HomeTown Bankshares 10Q 2017 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒	Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended June 30, 2017.

☐	Transition Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the transition period from to .

Commission File Number: 333-158525

HOMETOWN BANKSHARES CORPORATION

(Exact name of the registrant as specified in its charter)

Virginia	26-4549960
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)

202 South Jefferson Street, Roanoke, Virginia	24011
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number: (540) 345-6000

(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	(Do not check if a smaller reporting company)
		Smaller reporting company	☒
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of August 11, 2017, 5,771,175 shares of common stock, par value $5.00 per share, of the issuer were outstanding.

HOMETOWN BANKSHARES CORPORATION

Form 10-Q

INDEX

PART I. FINANCIAL INFORMATION

Item 1.	FINANCIAL STATEMENTS

Consolidated Balance Sheets as of June 30, 2017 (unaudited) and December 31, 2016		3

Consolidated Statements of Income for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)		4

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)		5

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016 (unaudited)		6

Notes to Consolidated Financial Statements (unaudited)		7

Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	22

Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	33

Item 4.	CONTROLS AND PROCEDURES	33

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	34

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34

Item 3.	Defaults Upon Senior Securities	34

Item 4.	Mine Safety Disclosure	34

Item 5.	Other Information	34

Item 6.	Exhibits	34

SIGNATURES		35

All schedules have been omitted because they are inapplicable or the required information is provided in the financial statements, including the notes thereto.

HomeTown Bankshares Corporation

Consolidated Balance Sheets

June 30, 2017 and December 31, 2016

Dollars in Thousands, Except Share and Per Share Data	June 30, 2017		December 31, 2016

	(Unaudited)		*
Assets
Cash and due from banks	$	37,618	$	18,229
Federal funds sold		93		42
Securities available for sale, at fair value		48,665		52,975
Restricted equity securities, at cost		2,371		2,213
Loans held for sale		1,108		678
Loans, net of allowance for loan losses of $3,700 in 2017 and $3,636 in 2016		430,801		415,355
Property and equipment, net		13,177		13,371
Other real estate owned, net of valuation allowance of $589 in 2017 and $825 in 2016		2,768		3,794
Bank owned life insurance		7,566		7,469
Accrued income		2,451		2,289
Other assets		1,332		875
Total assets	$	547,950	$	517,290

Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	116,538	$	91,354
Interest-bearing		359,818		359,494
Total deposits		476,356		450,848
Federal Home Loan Bank borrowings		11,694		8,000
Subordinated notes		7,239		7,224
Other borrowings		1,100		1,117
Accrued interest payable		413		386
Other liabilities		1,313		1,490
Total liabilities		498,115		469,065

Commitments and contingencies

Stockholders’ equity:
Common stock, $5 par value; authorized 10,000,000 shares, issued and outstanding 5,769,175 (includes 28,679 restricted shares) at June 30, 2017 and 5,760,735 (includes 31,546 restricted shares) at December 31, 2016		28,766		28,765
Surplus		17,901		17,833
Retained earnings		2,446		1,247
Accumulated other comprehensive income (loss)		252		(56	)
Total HomeTown Bankshares Corporation stockholders’ equity		49,365		47,789
Noncontrolling interest in consolidated subsidiary		470		436
Total stockholders’ equity		49,835		48,225
Total liabilities and stockholders' equity	$	547,950	$	517,290

*Derived from consolidated audited financial statements.

See Notes to Consolidated Financial Statements

HomeTown Bankshares Corporation

Consolidated Statements of Income

For the three and six months ended June 30, 2017 and 2016

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
Dollars in Thousands, Except Share and Per Share Data	2017		2016		2017		2016
Interest and dividend income:	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Loans and fees on loans	$	4,703	$	4,337	$	9,327	$	8,593
Taxable investment securities		260		201		500		405
Nontaxable investment securities		76		101		164		202
Dividends on restricted stock		33		36		65		70
Other interest income		50		26		92		45
Total interest and dividend income		5,122		4,701		10,148		9,315
Interest expense:
Deposits		552		537		1,106		1,041
Subordinated notes		134		134		268		268
Other borrowed funds		60		70		114		167
Total interest expense		746		741		1,488		1,476
Net interest income		4,376		3,960		8,660		7,839
Provision for loan losses		465		808		535		868
Net interest income after provision for loan losses		3,911		3,152		8,125		6,971

Noninterest income:
Service charges on deposit accounts		146		164		296		318
ATM and interchange income		228		168		406		315
Mortgage banking		255		181		462		356
Gains on sales of investment securities, net		29		209		42		214
Other income		375		151		525		281
Total noninterest income		1,033		873		1,731		1,484

Noninterest expense:
Salaries and employee benefits		2,064		1,597		4,053		3,323
Occupancy and equipment expense		439		444		854		878
Data processing expense		318		210		645		442
ATM processing expense		61		58		123		112
Advertising and marketing expense		142		124		272		218
Professional fees		132		116		365		217
Bank franchise taxes		99		91		199		183
FDIC insurance expense		71		75		103		158
Losses on sales and write-downs of other real estate owned, net		380		91		380		91
Other real estate owned expense		24		25		37		47
Directors’ fees		108		102		209		209
Other expense		474		432		865		749
Total noninterest expense		4,312		3,365		8,105		6,627
Net income before income taxes		632		660		1,751		1,828
Income tax expense		176		434		518		787
Net income		456		226		1,233		1,041
Less net income attributable to non-controlling interest		22		2		34		16
Net income attributable to HomeTown Bankshares Corporation		434		224		1,199		1,025
Effective dividends on preferred stock		-		204		-		408
Net income available to common stockholders	$	434	$	20	$	1,199	$	617
Basic earnings per common share	$	0.08	$	0.00	$	0.21	$	0.17
Diluted earnings per common share	$	0.08	$	0.00	$	0.21	$	0.11
Weighted average common shares outstanding		5,768,670		3,557,763		5,766,041		3,529,605
Diluted weighted average common shares outstanding		5,789,905		5,780,122		5,787,276		5,776,832

See Notes to Consolidated Financial Statements

HomeTown Bankshares Corporation

Consolidated Statements of Comprehensive Income

For the three and six months ended June 30, 2017 and 2016

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2017			2016			2017			2016
Dollars In Thousands	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net income	$	456		$	226		$	1,233		$	1,041

Other comprehensive income:
Net unrealized holding gains on securities available for sale during the period		431			422			509			732
Deferred income tax (expense) on unrealized holding gains on securities available for sale		(146	)		(143	)		(173	)		(249	)
Reclassification adjustment for gains on sales of investment securities included in net income		(29	)		(209	)		(42	)		(214	)
Tax expense related to realized gains on securities sold		10			71			14			73
Total other comprehensive income		266			141			308			342

Comprehensive income		722			367			1,541			1,383
Less: Comprehensive income attributable to the non-controlling interest		22			2			34			16
Comprehensive income attributable to HomeTown Bankshares Corporation	$	700		$	365		$	1,507		$	1,367

See Notes to Consolidated Financial Statements

HomeTown Bankshares Corporation

Consolidated Statements of Cash Flows

For the six months ended June 30, 2017 and 2016

	For the Six Months Ended June 30,
Dollars in Thousands	2017			2016
Cash flows from operating activities:	(Unaudited)			(Unaudited)
Net income	$	1,233		$	1,041
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		367			379
Provision for loan losses		535			868
Amortization of premium on securities, net		238			286
Amortization of discount on subordinated notes		15			15
Gains on sales of loans held for sale		(327	)		(255	)
Losses on sales and write-downs of other real estate, net		380			91
Gains on sales of investment securities, net		(42	)		(214	)
Increase in value of life insurance contracts		(97	)		(86	)
Stock compensation expense		73			75
Originations of loans held for sale		(15,383	)		(10,253	)
Proceeds from sales of loans held for sale		15,280			11,236
Changes in assets and liabilities:
Accrued income		(162	)		(14	)
Other assets		(440	)		(776	)
Deferred taxes, net		(175	)		221
Accrued interest payable		27			39
Other liabilities		(177	)		(406	)
Net cash flows provided by operating activities		1,345			2,247
Cash flows from investing activities:
Net (increase) decrease in federal funds sold		(51	)		375
Purchases of available for sale securities		(6,696	)		(10,794	)
Sales, maturities, and calls of available for sale securities		11,276			9,286
(Purchase) redemption of restricted equity securities, net		(158	)		56
Net increase in loans		(15,981	)		(27,500	)
Proceeds from sales of other real estate		646			1,282
Purchases of property and equipment		(173	)		(97	)
Net cash flows used in investing activities		(11,137	)		(27,392	)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits		25,184			6,146
Net increase in interest-bearing deposits		324			27,583
Net increase (decrease) in FHLB borrowings		3,694			(7,350	)
Net increase (decrease) in other borrowings		(17	)		(1,465	)
Proceeds from exercise of stock options		13			–
Preferred stock dividend payment		–			(408	)
Net settlement restricted stock and cash in lieu of fractional shares		(17	)		(5	)
Net cash flows provided by financing activities		29,181			24,501
Net increase (decrease) in cash and cash equivalents		19,389			(644	)
Cash and cash equivalents, beginning		18,229			28,745
Cash and cash equivalents, ending	$	37,618		$	28,101
Supplemental disclosure of cash flow information:
Cash payments for interest	$	1,446		$	1,437
Cash payments for income taxes	$	786		$	1,253
Supplemental disclosure of noncash investing activities:
Change in unrealized gains on available for sale securities	$	467		$	518
Transfer from loans to other real estate	$	-		$	473
Conversion of Preferred Stock to Common Stock	$	-		$	12,893

See Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Organization

On September 4, 2009, Hometown Bankshares Corporation (the “Company”) acquired all outstanding stock of HomeTown Bank (the “Bank”) in an exchange for shares of the Company on a one-for-one basis to become a single-bank holding company with the Bank becoming a wholly-owned subsidiary. The Bank was organized and incorporated under the laws of the State of Virginia on November 9, 2004 and commenced operations on November 14, 2005. The Bank currently serves Roanoke City, Virginia, the County of Roanoke, Virginia, the City of Salem, Virginia, Christiansburg, Virginia, and surrounding areas. As a state chartered bank which is a member of the Federal Reserve System, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions, the Federal Deposit Insurance Corporation and the Federal Reserve Board.

Basis of Presentation

The consolidated financial statements as of June 30, 2017 and for the periods ended June 30, 2017 and 2016 included herein, have been prepared by HomeTown Bankshares Corporation, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.

Management believes that all interim adjustments for the periods ended June 30, 2017 are of a normal recurring nature. In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s financial position, results of operations and cash flows for such interim periods. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto as of December 31, 2016, included in the Company’s Form 10-K for the year ended December 31, 2016. Interim financial performance is not necessarily indicative of performance for the full year.

The accounting and reporting policies of the Company follow generally accepted accounting principles and general practices within the financial services industry.

The consolidated financial statements of HomeTown Bankshares Corporation include the accounts of its wholly-owned subsidiary HomeTown Bank and the accounts of its subsidiary, HomeTown Residential Mortgage LLC. HomeTown Bank owns a 49% interest in HomeTown Residential Mortgage LLC which originates and sells mortgages secured by personal residences. Due to the marketing support and direction provided by HomeTown Bank to HomeTown Residential Mortgage LLC, along with guarantees of warehouse lines of credit used in its operation, the Company is deemed to exercise control of this entity. The ownership interest in HomeTown Residential Mortgage LLC not owned by the Company is reported as Non-Controlling Interest in a Consolidated Subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company’s accounting policies and basic principles have not changed since the summary disclosure of these in our Annual Report on Form 10-K. Please refer to Form 10-K for these policies.

Note 2. Investment Securities

The amortized cost and fair value of available-for-sale securities as of June 30, 2017 and December 31, 2016, are as follows:

(Dollars In Thousands)	June 30, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government agency securities	$	11,140	$	136	$	(31	)	$	11,245
Mortgage-backed securities and CMO’s		19,811		64		(131	)		19,744
Corporate securities		4,500		105		–			4,605
Municipal securities		12,832		324		(85	)		13,071
	$	48,283	$	629	$	(247	)	$	48,665

(Dollars In Thousands)	December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government agency securities	$	12,422	$	118	$	(96	)	$	12,444
Mortgage-backed securities and CMO’s		19,979		54		(265	)		19,768
Corporate securities		5,000		66		-			5,066
Municipal securities		15,659		266		(228	)		15,697
	$	53,060	$	504	$	(589	)	$	52,975

U. S. Government agency securities: The unrealized losses on ten of the Company’s investments in obligations of the U. S. government were caused by increases in market interest rates over the yields available at the time the securities were purchased. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments before recovery of their amortized cost basis which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2017.

Mortgage-backed securities and CMO’s: The unrealized losses on twenty-four of the Company’s investments in government-sponsored entity mortgage-backed securities and collateralized mortgage obligations (“CMOs”) were caused by increases in market interest rates over the yields available at the time the securities were purchased. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2017.

Corporate securities: The unrealized loss on one of the Company’s investments in corporate securities was caused by increases in market interest rates over the yield at the time the security was purchased. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider this investment to be other-than-temporarily impaired at June 30, 2017.

Municipal securities: The unrealized losses on eight of the Company’s investments in municipal securities were caused by increases in market interest rates over the yields available at the time the securities were purchased. All municipal securities are investment grade. Because the decline in market value is attributable to changes in interest rates, credit spreads, and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2017.

The following tables demonstrate the unrealized loss position of available-for-sale securities at June 30, 2017 and December 31, 2016. This information summarizes the amount of time individual securities have been in a continuous, unrealized loss position.

	June 30, 2017
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U. S. Government agency securities	$	1,466	$	(10	)	$	1,866	$	(21	)	$	3,332	$	(31	)
Mortgage-backed securities and CMO’s		12,793		(112	)		1,504		(19	)		14,297		(131	)
Corporate securities		250		-			-		-			250		-
Municipal securities		2,756		(73	)		763		(12	)		3,519		(85	)
	$	17,265	$	(195	)	$	4,133	$	(52	)	$	21,398	$	(247	)

	December 31, 2016
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government agency securities	$	3,492	$	(32	)	$	3,491	$	(64	)	$	6,983	$	(96	)
Mortgage-backed securities and CMO’s		14,232		(235	)		1,474		(30	)		15,706		(265	)
Corporate securities		500		-			-		-			500		-
Municipal securities		6,967		(223	)		262		(5	)		7,229		(228	)
	$	25,191	$	(490	)	$	5,227	$	(99	)	$	30,418	$	(589	)

There are forty-three debt securities with fair values totaling $21.4 million considered temporarily impaired at June 30, 2017. As of June 30, 2017, the Company does not consider any bond in an unrealized loss position to be other-than-temporarily impaired.

The Company realized gains of $102 thousand and $60 thousand of losses on sales of securities in the first six months of 2017. The Company realized gains of $219 thousand and $5 thousand of losses during the same period last year.

The amortized cost and fair values of investment securities available for sale at June 30, 2017, by contractual maturity are as follows:

(Dollars In Thousands)	Amortized Cost		Fair Value
One year or less	$	246	$	247
Over one through five years		2,376		2,392
Over five through ten years		14,048		14,229
Greater than 10 years		31,613		31,797
	$	48,283	$	48,665

Note 3. Loans Receivable

The major classifications of loans in the consolidated balance sheets at June 30, 2017 and December 31, 2016 were as follows:

(Dollars In Thousands)	June 30, 2017			December 31, 2016
Construction loans:
Residential	$	9,990		$	10,204
Land acquisition, development & commercial		31,778			27,480
Real estate:
Residential		113,434			111,626
Commercial		180,121			172,248
Commercial, industrial & agricultural		61,404			59,702
Equity lines		30,519			29,956
Consumer		7,200			7,668
Overdrafts		55			107
Total		434,501			418,991
Less allowance for loan losses		(3,700	)		(3,636	)
Loans, net	$	430,801		$	415,355

The past due and nonaccrual status of loans as of June 30, 2017 was as follows:

(Dollars In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Nonaccrual Loans
Construction loans:
Residential	$	−	$	−	$	−	$	−	$	9,990	$	9,990	$	−
Land acquisition, development & commercial		241		−		−		241		31,537		31,778		−
Real estate:
Residential		1,183		190		577		1,950		111,484		113,434		577
Commercial		817		−		−		817		179,304		180,121		2,748
Commercial, industrial & agricultural		45		16		10		71		61,388		61,459		27
Equity lines		225		104		−		329		30,190		30,519		−
Consumer		30		-		7		37		7,163		7,200		−
Total	$	2,541	$	310	$	594	$	3,445	$	431,056	$	434,501	$	3,352

The past-due and nonaccrual status of loans as of December 31, 2016 was as follows:

(Dollars In Thousands)	30-59 Days Past-Due		60-89 Days Past-Due		90 Days or More Past-Due		Total Past- Due		Current		Total Loans		Nonaccrual Loans
Construction:
Residential	$	−	$	−	$	−	$	−	$	10,204	$	10,204	$	−
Land acquisition, development & commercial		−		−		−		−		27,480		27,480		−
Real Estate:
Residential		672		193		577		1,442		110,184		111,626		577
Commercial		115		−		−		115		172,133		172,248		336
Commercial, industrial & agricultural		60		33		−		93		59,716		59,809		11
Equity lines		258		−		−		258		29,698		29,956		−
Consumer		8		6		4		18		7,650		7,668		−
Total	$	1,113	$	232	$	581	$	1,926	$	417,065	$	418,991	$	924

There were two credit card accounts, totaling $17 thousand, which were past due ninety days or more as of June 30, 2017. There were two loans, totaling $4 thousand, which were past due ninety days or more and still accruing interest at December 31, 2016.

Impaired loans, which include TDR’s of $4.2 million, and the related allowance at June 30, 2017, were as follows:

June 30, 2017

With no related allowance:

(Dollars In Thousands)

Recorded

Investment

in Loans

Unpaid

Principal

Balance

Allowance

Average

Balance

Total

Loans

Interest

Income

Recognized

Construction loans:

Residential

−

Land acquisition, development & commercial

−

Real estate:

Residential

767

−

768

Commercial

6,593

6,769

−

7,053

Commercial, industrial & agricultural

−

Equity lines

−

Consumer

−

Total loans with no allowance

7,387

7,563

−

7,849

June 30, 2017

With an allowance recorded:

(Dollars In Thousands)

Recorded

Investment

in Loans

Unpaid

Principal

Balance

Allowance

Average

Balance

Total

Loans

Interest

Income

Recognized

Construction loans:

Residential

−

Land acquisition, development & commercial

−

Real estate:

Residential

−

Commercial

108

112

−

Commercial, industrial & agricultural

−

Equity lines

−

Consumer

−

Total loans with an allowance

108

112

−

Impaired loans, which include TDRs of $6.4 million, and the related allowance at December 31, 2016, were as follows:

December 31, 2016

With no related allowance:

(Dollars In Thousands)

Recorded

Investment

in Loans

Unpaid

Principal

Balance

Allowance

Average

Balance

Total Loans

Interest

Income

Recognized

Construction:

Residential

−

–

−

Land acquisition, development & commercial

−

–

−

Real Estate:

Residential

770

–

629

(11

)

Commercial

6,380

6,556

–

6,521

255

Commercial, industrial & agricultural

–

−

Equity lines

−

–

−

Consumer

−

–

−

Total loans with no allowance

7,161

7,337

–

7,161

244

December 31, 2016

With an allowance recorded:

(Dollars In Thousands)

Recorded

Investment

in Loans

Unpaid

Principal

Balance

Allowance

Average

Balance

Total Loans

Interest

Income

Recognized

Construction:

Residential

−

Land acquisition, development & commercial

−

Real Estate:

Residential

−

Commercial

115

122

−

Commercial, industrial & agricultural

−

Equity lines

−

Consumer

−

Total loans with an allowance

115

122

−

Troubled Debt Restructurings

Troubled debt restructurings (“TDR’s”) were comprised of five loans totaling $4.2 million at June 30, 2017. This compares with $6.4 million in total restructured loans at December 31, 2016. Two of the five loans totaling $4.0 million were accruing at June 30, 2017. The other three loans totaling $241 thousand were on nonaccrual status at the end of the second quarter of 2017. Two TDRs totaling $549 thousand were past due with their restructured terms at June 30, 2017.

The following table presents by class of loan, information related to the loan modified in a TDR during 2017:

(Dollars in Thousands)	Loans modified as TDR's For the six months ended June 30, 2017
Class of Loan	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Construction loans:
Residential		—	$	—	$	—
Land acquisition, development & commercial		—		—		—
Real estate loans:
Residential		—		—		—
Commercial		1		218		218
Commercial, industrial, agricultural		—		11		29
Equity lines		—		—		—
Consumer		—		—		—
Total Loans		1	$	229	$	247

The loan relationship identified above in the table was originally restructured into two TDR’s during 2015 and was included in substandard nonaccrual loans and impaired loans at the end of 2016. There was an additional $18 thousand added to the TDR relationship during the first quarter of 2017.

No loans were modified in a TDR during the first six months of 2016.

Management considers troubled debt restructurings and subsequent defaults in restructured loans in the determination of the adequacy of the Company’s allowance for loan losses. When identified as a TDR, a loan is evaluated for potential loss based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs if the loan is collateral dependent. Loans identified as TDRs frequently are on non-accrual status at the time of the restructuring and, in some cases, partial charge-offs may have already been taken against the loan and a specific allowance may have already been established for the loan. As a result of any modification as a TDR, if a specific reserve is associated with the loan it may be increased. Additionally, loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future defaults. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. As a result, any specific allowance may be increased, adjustments may be made in the allocation of the total allowance balance, or partial charge-offs may be taken to further write-down the carrying value of the loan. Management exercises significant judgment in developing estimates for potential losses associated with TDRs.

Note 4. Allowance for Loan Losses

The following table presents, as of June 30, 2017, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

June 30, 2017	Allowance for loan losses																Loans
Class of Loan (Dollars in Thousands)	Beginning balance		Charge- offs			Recoveries		Provisions			Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment
Construction loans:
Residential	$	63	$	−		$	−	$	(2	)	$	61	$	−	$	61	$	9,990	$	−	$	9,990
Land acquisition, development & commercial		173		−			−		31			204		−		204		31,778		−		31,778
Real estate:				−
Residential		866		−			−		(51	)		815		−		815		113,434		767		112,667
Commercial		1,516		(430	)		38		615			1,739		17		1,722		180,121		6,701		173,420
Commercial, industrial & agricultural		461		(57	)		−		69			473		−		473		61,459		27		61,432
Equity lines		338		−			−		(57	)		281		−		281		30,519		−		30,519
Consumer		97		(39	)		17		22			97		−		97		7,200		−		7,200
Unallocated		122		−			−		(92	)		30		−		30		−		−		−
Total	$	3,636	$	(526	)	$	55	$	535		$	3,700	$	17	$	3,683	$	434,501	$	7,495	$	427,006

The following table presents, as of December 31, 2016, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

December 31, 2016	Allowance for loan losses																Loans
Class of Loan (Dollars in Thousands)	Beginning balance		Charge- offs			Recoveries		Provisions			Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment
Construction loans:
Residential	$	83	$	−		$	−	$	(20	)	$	63	$	−	$	63	$	10,204	$	−	$	10,204
Land acquisition, development & commercial		187		(2	)		−		(12	)		173		−		173		27,480		−		27,480
Real estate:
Residential		1,047		(4	)		45		(222	)		866		−		866		111,626		770		110,856
Commercial		1,001		(606	)		−		1,121			1,516		17		1,499		172,248		6,495		165,753
Commercial, industrial & agricultural		531		(34	)		−		(36	)		461		−		461		59,809		11		59,798
Equity lines		277		(99	)		10		150			338		−		338		29,956		−		29,956
Consumer		85		(103	)		49		66			97		−		97		7,668		−		7,668
Unallocated		87		−			−		35			122		−		122		−		−		−
Total	$	3,298	$	(848	)	$	104	$	1,082		$	3,636	$	17	$	3,619	$	418,991	$	7,276	$	411,715

Loans by credit quality indicators as of June 30, 2017 were as follows:

(Dollars in Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Total
Construction loans:
Residential	$	9,990	$	−	$	−	$	−	$	9,990
Land acquisition, development & commercial		31,778		−		−		−		31,778
Real estate loans:
Residential		112,667		−		190		577		113,434
Commercial		176,840		−		533		2,748		180,121
Commercial, industrial, agricultural		60,806		83		543		27		61,459
Equity lines		30,519		−		−		−		30,519
Consumer		7,200		−		−		−		7,200
Total Loans	$	429,800	$	83	$	1,266	$	3,352	$	434,501

Loans by credit quality indicators as of December 31, 2016 were as follows:

(Dollars in Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Total
Construction loans:
Residential	$	10,204	$	−	$	−	$	−	$	10,204
Land acquisition, development & commercial		27,480		−		−		−		27,480
Real estate loans:
Residential		110,856		−		193		577		111,626
Commercial		171,369		−		543		336		172,248
Commercial, industrial, agricultural		59,120		78		600		11		59,809
Equity lines		29,956		−		−		−		29,956
Consumer		7,668		−		−		−		7,668
Total Loans	$	416,653	$	78	$	1,336	$	924	$	418,991

At June 30, 2017 and December 31, 2016, the Company had no loans classified as Doubtful or Loss.

Note 5. Other Real Estate Owned

Changes in other real estate owned for the six months ended June 30, 2017 were as follows:

(Dollars in Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	4,619		$	(825	)	$	3,794
Additions		—			—			—
Write downs		—			(380	)		(380	)
Sales		(1,262	)		616			(646	)
Balance at quarter end	$	3,357		$	(589	)	$	2,768

Changes in foreclosed properties for the six months ended June 30, 2016 were as follows:

(Dollars in Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	5,657		$	(420	)	$	5,237
Additions		473			—			473
Write downs		—			—			—
Sales		(1,373	)		—			(1,373	)
Balance at quarter end	$	4,757		$	(420	)	$	4,337

The major classifications of other real estate owned in the consolidated balance sheets at June 30, 2017 and December 31, 2016 were as follows:

(Dollars in Thousands)	June 30, 2017		December 31, 2016
Residential lots	$	2,187	$	2,234
Residential development		43		423
Commercial lots		90		90
Commercial buildings		448		1,047
Total Other Real Estate Owned	$	2,768	$	3,794

There were no residential real estate loans in the process of foreclosure at June 30, 2017 or December 31, 2016.

Other real estate owned related expenses in the consolidated statements of income for the three and six months ended June 30, 2017 and June 30, 2016 include:

(Dollars In Thousands)	Three months Ended June 30, 2017		Three months Ended June 30, 2016		Six months Ended June 30, 2017		Six months Ended June 30, 2016
Net loss on sales	$	—	$	91	$	—	$	91
Provision for unrealized losses		380		—		380		—
Operating expenses		24		25		37		47
Total Other Real Estate Owned	$	404	$	116	$	417	$	138

Note 6. Stock Based Compensation

The Company recorded stock based compensation expense of $73 thousand and $75 thousand for the years to date June 30, 2017 and 2016, respectively.

The 2005 Stock Option Plan (the Plan) pursuant to which the Board of Directors granted stock options to directors, officers and employees expired in 2016, thus there are no options available for future issuance. Under the fair value recognition provisions of relevant accounting guidance, stock-based compensation cost was measured at the grant date based on the fair value of the award and was and continues to be recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

The Company used the Black-Scholes option pricing model to determine the fair value of stock options. The fair value of the stock based payment awards was affected by the price of the Company's stock and a number of financial assumptions and variables. These variables included the risk-free interest rate, expected dividend rate, expected stock price volatility and the expected life of the options. No stock options were granted during 2017 or 2016. Compensation expense is charged to income ratably over the vesting period and was $36 thousand and $40 thousand for the year to date June 30, 2017 and June 30, 2016, respectively. As of June 30, 2017, there was $176 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost will be recognized over the next 2.50 years. At the discretion of the Board of Directors, the stock option plan was not modified for the 4% stock dividend distributed on July 11, 2016.

A summary of option activity under the 2005 stock option plan year to date June 30, 2017 is as follows:

	Options Outstanding			Weighted Average Exercise Price		Aggregate Intrinsic Value (1)		Weighted Average Contractual Term (years)
Balance at December 31, 2016		201,000		$	7.80
Granted		–			–
Exercised		(2,000	)		6.90
Expired		–			–
Forfeited		–			–
Balance at June 30, 2017		199,000		$	7.81	$	605,017		6.00
Exercisable at June 30, 2017		107,200		$	8.59	$	251,577		4.73

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2017.

In 2009, the Board of Directors authorized 132,000 shares of common stock for issuance under the Restricted Stock Plan. On July 11, 2016, a 4% stock dividend was distributed and added 5,280 to the total number of shares authorized for issuance and currently raising the total available to 137,280. The plan provides for restricted stock awards to key employees. Restricted shares awarded to employees generally vest over a five year period and compensation expense is charged to income ratably over the vesting period and was $37 thousand and $35 thousand for the years to date June 30, 2017 and 2016, respectively. Compensation is accounted for using the fair market value of the Company’s common stock on the date the restricted shares are awarded. The Company granted 8,258 and 11,149* shares of restricted stock under the plan during the years to date June 30, 2017 and June 30, 2016, respectively. The weighted-average grant date fair value of restricted stock granted in 2017 was $9.87 compared to $9.09* in 2016.

As of June 30, 2017, there was $209 thousand of total unrecognized compensation cost related to restricted stock granted under the Plan. The cost is expected to be recognized through 2022. A summary of the activity for restricted stock awards for the periods indicated is presented below:

	For the Six Months Ended June 30, 2017					For the Six Months Ended June 30, 2016
	Shares			Weighted- Average Grant Date Fair Value		Shares				Weighted- Average Grant Date Fair Value
Nonvested at beginning of year		31,546		$	7.03		39,352		*	$	6.00	*
Granted		8,258			9.87		11,149		*		9.09	*
Vested		(11,125	)		6.03		(11,371	)	*		5.44	*
Forfeited		-			-		(6,788	)	*		6.99	*
Nonvested at the end of the period		28,679		$	8.23		32,342		*	$	7.06	*

The Restricted Stock Plan provides for the adjustment of the total number of shares reserved for issuance under the plan and the number of shares covered by each outstanding Award for stock dividends and stock splits.

*Restated for the 4% stock dividend distributed July 11, 2016.

Note 7. Fair Value Measurement

The Company uses a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

Level 1 - Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2 - Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

Level 3 - Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016:

(Dollars in Thousands)

Carrying value at June 30, 2017

Description

Balance as of

June 30, 2017

Quoted Prices

in Active Markets for

Identical Assets

(Level 1)

Significant

Other

Observable

Inputs

(Level 2)

Significant

Unobservable

Inputs

(Level 3)

Assets:

U.S. Government agency securities

11,245

–

11,245

–

Mortgage-backed securities and CMO’s

19,744

–

19,744

–

Corporate securities

4,605

–

4,605

–

Municipal securities

13,071

–

13,071

–

(Dollars in Thousands)

Carrying value at December 31, 2016

Description

Balance as of

December 31,

2016

Quoted Prices

in Active Markets for

Identical Assets

(Level 1)

Significant

Other

Observable

Inputs

(Level 2)

Significant

Unobservable

Inputs

(Level 3)

Assets:

U.S. Government agency securities

12,444

–

12,444

–

Mortgage-backed securities and CMO’s

19,768

–

19,768

–

Corporate securities

5,066

–

5,066

–

Municipal securities

15,697

–

15,697

–

Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles (GAAP). Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Impaired Loans: The Company does not record loans at fair value on a recurring basis. However, from time to time a loan is considered impaired and a specific reserve is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the extent of any loss. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value, and discounted cash flow. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investment in such loans. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. If carried at market price based on appraised value less selling costs using observable market data, it is recorded as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraisal value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Loans held for sale: The carrying value of these loans approximates the fair value. These loans close in the name of the Bank’s consolidated joint venture subsidiary HomeTown Residential Mortgage, LLC, but are generally sold within a two-week period.

Other Real Estate Owned (OREO): The carrying amount of real estate owned by the Company resulting from foreclosures is estimated at the lesser of cost or the fair value of the real estate based on an observable market price or a current appraised value less selling costs. If carried at market price based on appraised value using observable market data, it is recorded as nonrecurring Level 2. When an appraised value is not available or is not current, or management determines the fair value of the real estate is further impaired below the appraised value or there is no observable market price, the Company records the real estate as nonrecurring Level 3.

The following tables summarize the Company’s assets that were measured at fair value on a nonrecurring basis as of June 30, 2017 and December 31, 2016.

(Dollars in Thousands)

Carrying value at June 30, 2017

Description

Balance as of

June 30,

2017

Quoted Prices

in Active Markets

for Identical Assets

(Level 1)

Significant

Other

Observable

Inputs

(Level 2)

Significant

Unobservable

Inputs

(Level 3)

Assets:

Impaired loans, net of valuation allowance

–

Loans held for sale

1,108

–

1,108

–

Other real estate owned

2,768

–

2,768

(Dollars in Thousands)

Carrying value at December 31, 2016

Description

Balance as of

December 31,

2016

Quoted Prices

in Active Markets

for Identical Assets

(Level 1)

Significant

Other

Observable

Inputs

(Level 2)

Significant

Unobservable

Inputs

(Level 3)

Assets:

Impaired loans, net of valuation allowance

–

Loans held for sale

678

–

678

–

Other real estate owned

3,794

–

3,794

At June 30, 2017 and December 31, 2016, the Company did not have any liabilities measured at fair value on a nonrecurring basis.

The following table displays quantitative information about Level 3 Fair Value Measurements for June 30, 2017:

(Dollars in Thousands)	Quantitative information about Level 3 Fair Value Measurements for June 30, 2017
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Impaired loans	$	91	Discounted appraised value	Residual cash flows discount rate		6%	-	6%	(6	%)

Other real estate owned	$	1,513	Discounted appraised value	Selling cost		6%	-	6%	(6	%)
				Discount for lack of marketability and age of appraisal		4%	-	12%	(10	%)

	$	1,255	Internal evaluations	Internal evaluations		3%	-	90%	(19	%)

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2016:

(Dollars in Thousands)	Quantitative information about Level 3 Fair Value Measurements for December 31, 2016
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Impaired loans	$	98	Discounted appraised value	Residual cash flows discount rate		6%	-	6%	(6	%)

Other real estate owned	$	1,560	Discounted appraised value	Selling cost		6%	-	6%	(6	%)
				Discount for lack of marketability and age of appraisal		4%	-	12%	(10	%)

	$	2,234	Internal evaluations	Internal evaluations		4%	-	54%	(24	%)

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and due from banks: The carrying amounts reported in the consolidated balance sheet for cash on hand and amounts due from correspondent banks approximate their fair values.

Federal funds sold: Federal funds sold consist of overnight loans to other financial institutions and mature within one to three days. At June 30, 2017 and December 31, 2016, management believes the carrying value of federal funds sold approximates estimated market value.

Restricted equity securities: For these restricted equity securities, the carrying amount is a reasonable estimate of fair value based on the redemption provisions of the related securities.

Loans held for sale: The carrying value of these loans approximates the fair value. These loans close in the name of the Bank’s joint venture subsidiary HomeTown Residential Mortgage, LLC, but are generally sold within a two-week period.

Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Bank owned life insurance: The cash values of these policies are estimates using information provided by insurance carriers. The policies are carried at their cash surrender value, which approximates fair value.

Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit and individual retirement accounts are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of contractual maturities on such time deposits.

FHLB borrowings: The fair values for FHLB borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on FHLB borrowings to the contractual maturities on such FHLB borrowings.

Subordinated notes: The fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

Other borrowings: The warehouse line of credit is a short term revolving credit facility used to fund mortgage loans originations until the underlying loan is sold. The warehouse line of credit, federal funds purchased, borrowings under repurchase agreements mature within 30 days and approximate their fair values.

Accrued interest: The carrying amount of accrued interest receivable and payable approximates fair value.

Off-balance sheet financial instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements. At June 30, 2017 and December 31, 2016, the fair value of loan commitments and standby letters of credit were deemed to be immaterial.

The carrying amounts and approximate fair values of the Company's financial instruments are as follows at June 30, 2017:

(Dollars in Thousands)			Fair value at June 30, 2017
Description	Carrying value as of June 30, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Approximate Fair Values
Financial assets
Cash and due from banks	$	37,618	$	37,618	$	–	$	–	$	37,618
Federal funds sold		93		93		–		–		93
Securities available for sale		48,665		–		48,665		–		48,665
Restricted equity securities		2,371		–		2,371		–		2,371
Loans held for sale		1,108		–		1,108		–		1,108
Loans, net		430,801		–		–		431,796		431,796
Bank owned life insurance		7,566		–		7,566		–		7,566
Accrued income		2,451		–		2,451		–		2,451
Financial liabilities
Total deposits		476,356		–		476,637		–		476,637
FHLB borrowings		11,694		–		11,691		–		11,691
Subordinated notes		7,239		–		8,024		–		8,024
Other borrowings		1,100		–		1,100		–		1,100
Accrued interest payable		413		–		413		–		413

The carrying amounts and approximate fair values of the Company's financial instruments are as follows at December 31, 2016:

(Dollars in Thousands)			Fair value at December 31, 2016
Description	Carrying value as of December 31, 2016		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Approximate Fair Values
Financial assets
Cash and due from banks	$	18,229	$	17,479	$	760	$	–	$	18,239
Federal funds sold		42		42		–		–		42
Securities available for sale		52,975		–		52,975		–		52,975
Restricted equity securities		2,213		–		2,213		–		2,213
Loans held for sale		678		–		678		–		678
Loans, net		415,355		–		–		415,039		415,039
Bank owned life insurance		7,469		–		7,469		–		7,469
Accrued income		2,289		–		2,289		–		2,289
Financial liabilities
Total deposits		450,848		–		451,385		–		451,385
FHLB borrowings		8,000		–		8,031		–		8,031
Subordinated notes		7,224		–		8,012		–		8,012
Other borrowings		1,117		–		1,117		–		1,117
Accrued interest payable		386		–		386		–		386

Note 8. Reclassifications Out of Other Comprehensive Income

Items reclassified in their entirety to net income for the three and six months ended June 30, 2017 and 2016 are as follows:

Details about Other Comprehensive Components	Amounts Reclassified from Other Comprehensive Income for the Three Months Ended June 30,				Affected Line Item in the Statement Where Net Income is Presented
(Dollars In Thousands)	2017		2016
Available for sale securities
Realized gains on sales of securities held for sale during the period consider available for sale	$	29	$	209	Gains on sales of investment securities
Tax expense related to realized gains on securities sold		10		71	Income tax expense
	$	19	$	138	Net income

Details about Other Comprehensive Components	Amounts Reclassified from Other Comprehensive Income for the Six Months Ended June 30,				Affected Line Item in the Statement Where Net Income is Presented
(Dollars In Thousands)	2017		2016
Available for sale securities
Realized gains on sales of securities held for sale during the period consider available for sale	$	42	$	214	Gains on sales of investment securities
Tax expense related to realized gains on securities sold		14		73	Income tax expense
	$	28	$	141	Net income

Note 9. Earnings per Common Share

The following tables show the weighted average number of shares used in computing earnings per common share and the effect on weighted average number of shares of diluted potential common stock. All of the remaining Series C Preferred Stock was converted to common stock on June 29, 2016.

	For the Three Months Ended June 30,
	2017						2016
Dollars in Thousands, except share and per share data	Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount		Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		5,768,670	$	434	$	0.08		3,557,763	$	20	$	0.00
Series C Preferred Stock Dividends				−						−
Effect of dilutive securities:
Convertible preferred stock		−		−		−		2,213,303		−		−
Dilutive stock options		21,235		−		−		9,056		−		−
Earnings per common share, diluted		5,789,905	$	434	$	0.08		5,780,122	$	20	$	0.00

	For the Six Months Ended June 30,
	2017						2016
Dollars In Thousands, except share and per share data	Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount		Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		5,766,041	$	1,199	$	0.21		3,529,605	$	617	$	0.17
Series C Preferred Stock Dividends				−						−
Effect of dilutive securities:
Convertible preferred stock		−		−				2,238,171		−		(0.08	)
Dilutive stock options		21,235		−				9,056		−		−
Earnings per common share, diluted		5,787,276	$	1,199	$	0.21		5,776,832	$	617	$	0.11

At June 30, 2017 and 2016, the number of stock options considered antidilutive and excluded from the calculation of diluted weighted average shares was 33,000 and 49,500, respectively. Nonvested restricted shares were included in weighted average common shares outstanding for computing basic earnings per share, as the holder has voting rights and would share in a stock or cash dividend during the vesting period.

Note 10. Subsequent Events

There were no reportable subsequent events.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Forward-looking Statements

HomeTown Bankshares makes forward-looking statements in this report. These forward-looking statements may include: statements of goals, intentions, earnings expectations, and other expectations; estimates of risks and of future costs and benefits; assessments of probable loan and lease losses; assessments of market risk; and statements of the ability to achieve financial and other goals. Forward-looking statements are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “project” and other similar words and expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made. The Company does not assume any duty and does not undertake to update its forward-looking statements. Because forward-looking statements are subject to assumptions and uncertainties, actual results or future events could differ, possibly materially, from those that the Company anticipated in its forward-looking statements; and future results could differ materially from historical performance.

The Company’s forward-looking statements are subject to the following principal risks and uncertainties: general economic conditions and trends, either nationally or locally; conditions in the securities markets; changes in interest rates; changes in deposit flows, and in the demand for deposit, loan, and investment products and other financial services; changes in real estate values; changes in the quality or composition of the Company’s loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; the Company’s ability to retain key members of management; changes in legislation, regulation, and policies; and a variety of other matters which, by their nature, are subject to significant uncertainties. The Company provides greater detail regarding some of these factors in its Form 10-K for the year ended December 31, 2016. The Company’s forward-looking statements may also be subject to other risks and uncertainties, including those that it may discuss elsewhere in this report or in its other filings with the SEC.

Our Business

HomeTown Bankshares provides a full complement of consumer and commercial banking services to its primary service area which includes the Roanoke Valley, the New River Valley and Smith Mountain Lake. The Company serves these markets through a network of six branches, seven ATM’s, HomeTown Mortgage and HomeTown Investments. A high level of responsive and personal service coupled with local decision-making are the hallmarks of the Company’s customer oriented strategy. The Company offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, residential and commercial mortgages, home equity loans, consumer installment loans, commercial loans, and lines and letters of credit. In addition to its main office, the Company has offices in Franklin County, Virginia at Westlake; in the town of Christiansburg, Virginia at 2950 Market Street; in Roanoke County, Virginia at the intersection of Colonial Avenue and Virginia Route 419; in the City of Roanoke, Virginia at 3521 Franklin Road; and in the City of Salem, Virginia at 852 West Main Street. HomeTown Bank, with a 49% interest in the joint venture HomeTown Residential Mortgage, LLC, operates a dedicated mortgage office on Colonial Ave., next to the existing branch. The Company has a secure Operations Center at 4633 Brambleton Avenue in Roanoke.

HomeTown Investments provides diverse investment products and financial advisory services to existing and prospective customers. These products and services provide another source of revenue for the Company. Investment and insurance products and services are offered through an unaffiliated entity LPL Financial, Member FINRA/SIPC. HomeTown Investments is a subsidiary of the Bank. Products and services made available through LPL Financial are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.

The Private Banking Group offers personalized banking solutions to work with customers to clarify financial goals and bring together professionals to satisfy their investment, credit, and other financial needs.

The following is a discussion of factors that significantly affected the financial condition and results of operations of HomeTown Bankshares Corporation. This discussion should be read in connection with the financial statements presented herein.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in Note 1 of the Notes to Financial Statements in the Annual Report for the year ended December 31, 2016. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses.

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) that losses be accrued when they are probable of occurring and are capable of estimation and (ii) that losses on impaired loans be accrued based on the differences between the value of collateral less cost to sell, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses is maintained at a level, which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio.

The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a detailed quarterly analysis of the allowance based on the Company’s historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions, and economic trends. These are generally grouped by homogeneous loan pools. Allowances for impaired loans are generally determined based on collateral values less cost to sell, or the present value of estimated cash flows. This allowance, then, is designated as a specific reserve. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms.

Discussion of Operations

Executive Summary

HomeTown Bankshares Corporation reached $548 million in assets with strong growth in both loans and core deposits. The Company reported net income of $434 for the second quarter ended June 30, 2017 compared to $765 thousand for the previous quarter and $224 thousand for the comparative period in 2016. Net Income for the first six months of 2017 was $1.2 million compared to $1.0 million for the first six months of 2016. Earnings per share on a fully diluted basis were $0.08 for the second quarter of 2017 and $0.21 per share for the six months ended June 30, 2017 compared to $0.00 and $0.11 per share, respectively, for the same periods in 2016.

Profitability was higher in the second quarter of 2017 and the first six months of 2017 compared to 2016. The increased profitability in 2017 was due to double digit growth in net interest income and non-interest income as well as a reduction in the provision for loan losses. Non-interest expenses were higher, mostly due to continued reduction in the OREO portfolio. A reduction in income tax expense also contributed to the higher profitability compared to 2016.

Three Months Ended June 30, 2017

Net income attributable to HomeTown Bankshares was $434 thousand for the second quarter of 2017, varying unfavorably from the previous quarter by $331 thousand, but $210 thousand more than the same quarter in 2016. Higher provision and noninterest expenses contributed to the decline from the previous quarter while less provision expense and tax expense contributed to the increase from the same quarter in 2016. Additionally, Net interest income and noninterest income for the second quarter of 2017 varied favorably from the previous quarter and the same quarter last year. Net interest income for the three months ended June 30, 2017 was $92 thousand greater than the first quarter of 2017 and $416 thousand more than the second quarter of 2016. Noninterest income rose $336 thousand over the prior quarter and $160 thousand over the same quarter in 2016. Higher net interest income and noninterest income was offset by increased noninterest expense from sale of a foreclosed property, higher professional fees, higher mortgage commissions and incentive accruals, data processing costs and software expenses due to increased customer base and core upgrade.

Net interest income for the three months ended June 30, 2017 totaled $4.4 million, and was $416 thousand or 10.5% greater than the same quarter in the prior year. The expansion of the loan portfolio and higher yielding investment securities provided $421 thousand in additional interest income. Average loans for the quarter were $432 million, $46 million or 11.9% more than the second quarter of 2016. Excess funds from increased liquidity were placed in interest bearing bank accounts until needed to fund further loan growth. Average interest-bearing deposits with banks were $7.9 million greater for the second quarter of 2017 than for the same quarter in 2016.

Deposits funded the expansion of the loan portfolio with total average interest bearing and noninterest-bearing deposits for the second quarter of 2017 of $463 million, an increase of $38.7 million over the average for the same quarter in 2016. Average FHLB borrowings for the three months ended June 30, 2017 was $12.9 million compared to $17.0 for the three months ended June 30, 2016.

The net interest margin was 3.48%, 3.54%, and 3.55% for the three months ended June 30, 2017, March 31, 2017, and June 30, 2016, respectively. Deposits were the major source of funding with rates generally increasing while loans have been slower to reprice. Continued downward pressure on rates stemming from competition in the market place also contributed to lower loan yields. Management decreased the average level of Federal Home Loan Bank borrowings by $4.2 million. Federal Home Loan Bank borrowings are generally more expensive than interest bearing deposits, and reducing reliance on them as a funding source favorably impacted the funding mix.

	For the Three Months Ended June 30, 2017								For the Three Months Ended June 30, 2016
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance		Interest Income/ Expense		Yield/ Rate
Assets:
Federal funds sold	$	50		$	—		0.83	%	$	1,479	$	2		0.39	%
Deposits in banks		18,801			50		1.06			10,950		24		0.89
Securities, taxable		37,751			260		2.76			38,665		201		2.08
Securities, nontaxable (1)		11,656			76		3.97			15,066		101		4.06
Restricted equity securities		2,417			33		5.51			2,559		36		5.60
Loans held for sale		745			8		4.13			466		4		3.74
Loans (1)		431,578			4,695		4.31			385,531		4,333		4.52
Total earnings assets		502,998			5,122		4.07			454,716		4,701		4.21
Less: Allowance for loan losses		(3,779	)							(3,404)
Total non-earning assets		37,371								47,568
Total Assets	$	536,590							$	498,880

Liabilities and shareholders’ equity
Interest bearing deposits:
Checking	$	91,805		$	40		0.17	%	$	77,437	$	27		0.14	%
Money market savings		72,060			44		0.25			73,118		44		0.24
Regular savings		49,895			43		0.35			41,112		38		0.37
Time Deposits		138,438			425		1.22			146,506		428		1.17
FHLB borrowings		12,850			52		1.61			17,048		65		1.51
Subordinated notes		7,234			134		7.41			7,204		134		7.44
Other borrowings		1,267			8		2.54			1,112		5		1.83
Total interest-bearing liabilities		374,549			746		0.80			363,537		741		0.82
Noninterest-bearing liabilities:
Demand deposits		110,364								85,645
Other liabilities		3,233								2,034
Total liabilities		488,146								451,216
Total HomeTown Bankshares Corporation stockholders’ equity		47,999								47,280
Non-controlling interest in consolidated subsidiary		445			—					384		—
Total Liabilities and Stockholders’ Equity	$	536,590			746				$	498,880		741
Net interest income				$	4,376						$	3,960
Interest rate spread							3.27							3.39
Interest expense to average earning assets							0.59							0.66
Net interest margin							3.48	%						3.55	%

(1) Yields are reported on a tax equivalent basis assuming a federal income tax rate of 34 percent.

	Three Months Ended June 30, 2017 Compared to Three Months Ended June 30, 2016
	Increase			Change Due To:
(Dollars in thousands)	(Decrease)			Rate			Volume
Interest income:
Federal funds sold	$	(2	)	$	1		$	(3	)
Deposits in banks		26			5			21
Securities, taxable		59			35			24
Securities, nontaxable		(25	)		(2	)		(23	)
Restricted equity securities		(3	)		(1	)		(2	)
Loans held for sale		4			1			3
Loans		362			(132	)		494
Total interest income		421			(93	)		514

Interest expense:
Interest bearing liabilities:
Checking		13			7			6
Money market savings		—			—			—
Regular savings		5			(2	)		7
Time Deposits		(3	)		15			(18	)
FHLB borrowings		(13	)		4			(17	)
Subordinated notes		—			—			—
Other borrowings		3			(2	)		5
Total interest expense		5			22			(17	)

Net interest income	$	416		$	(115	)	$	531

A provision for loan losses of $465 thousand was recorded for the three months ended June 30, 2017 compared to $70 thousand in the prior quarter and $808 thousand for the three months ended June 30, 2016. See discussion under Allowance for Loan Losses for additional information.

Noninterest income for the second quarter of 2017 was $1.0 million, and was $160 thousand more than the same period last year. ATM and interchange income were up $60 thousand for 2017 compared to 2016 due to growth in customer base and fully implementing the in-house credit card program during the 4^th quarter of 2016. Mortgage banking income was $74 thousand more than the prior year due to a higher volume of mortgages processed and sold. The second quarter of 2017 included $29 thousand in gains realized from the sales of investment securities compared to $209 in the second quarter of 2016. Volatility created by the Brexit referendum led to a surge in trading activity creating opportunities to realize gains in the bond markets during 2016. Proceeds were reinvested in higher yielding corporate bonds which contributed to the increased interest income. Other income was $224 thousand higher for the quarter ended June 30, 2017 compared to the same quarter last year. Favorable variances from the continued growth of merchant processing income and investment brokerage commission fees contributed to the increase as well as a one-time bankruptcy settlement of $172 thousand.

For the three months ended June 30, 2017, noninterest expense was $4.3 million, $947 thousand or 28% more than the $3.4 million recorded in the same quarter last year. Salaries and employee benefits for the three months ended June 30, 2017 were $467 thousand or 28% more than the same three months of 2016. For the quarter to quarter comparison, the amount of Accounting Standards Codification (ASC) 310-20 origination costs that were deferred was greater in 2016 than 2017 due to a higher volume of new loans and renewals; thus increasing 2017 salaries. Another factor contributing to higher salaries and employee benefits expense was the partial reversal of incentive bonus accruals in the second quarter of 2016 that has fully accrued through June 30, 2017. Also contributing to the increased expenses was a $380 thousand write-down of an OREO property in anticipation of 3^rd quarter 2017 sale. Higher professional fees, mortgage commissions, software expenses and data processing costs due to an increased customer base and core upgrade were also up from the same quarter in 2016.

Six months Ended June 30, 2017

Net income attributable to HomeTown Bankshares for the year through June 30, 2017 was $1.2 million, $174 thousand more than the earnings for the same period in 2016. Net interest income and noninterest income varied favorably from the prior year, but were negated by higher noninterest expense.

Net interest income was up $821 thousand or 10.5% to $8.7 million for the first half of 2017 over the first half of 2016. Higher loan volume helped to offset lower interest rates on loans and increased interest expense on deposits. A year-over year decline of 10 basis points in the net interest margin was realized from 3.49% for the first half of 2017 compared to 3.59% for the first half of 2016.

	For the Six Months Ended June 30, 2017								For the Six Months Ended June 30, 2016
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance			Interest Income/ Expense		Yield/ Rate
Assets:
Federal funds sold	$	48		$	—		0.73	%	$	1,481		$	3		0.38	%
Deposits in banks		18,580			92		1.00			9,656			42		0.88
Securities, taxable		38,319			500		2.61			38,067			405		2.13
Securities, nontaxable (1)		12,526			164		3.96			14,947			202		4.09
Restricted equity securities		2,373			65		5.50			2,579			70		5.45
Loans held for sale		611		��	12		4.08			420			8		3.84
Loans (1)		426,975			9,315		4.35			378,210			8,585		4.57
Total earnings assets		499,432			10,148		4.09			445,360			9,315		4.25
Less: Allowance for loan losses		(3,731	)							(3,348	)
Total non-earning assets		37,108								49,317
Total Assets	$	532,809							$	491,329

Liabilities and shareholders’ equity
Interest bearing deposits:
Checking	$	92,844		$	79		0.17	%	$	75,778		$	53		0.14	%
Money market savings		71,673			87		0.24			70,512			84		0.24
Regular savings		48,466			84		0.35			40,347			74		0.37
Time Deposits		143,016			856		1.21			143,849			830		1.16
FHLB borrowings		12,200			97		1.59			19,524			155		1.57
Subordinated notes		7,230			268		7.41			7,200			268		7.45
Other borrowings		1,462			17		2.16			1,380			12		1.76
Total interest-bearing liabilities		376,891			1,488		0.80			358,590			1,476		0.82
Noninterest-bearing liabilities:
Demand deposits		104,590								83,341
Other liabilities		1,953								2,011
Total liabilities		483,434								443,942
Total HomeTown Bankshares Corporation stockholders’ equity		48,932								47,004
Non-controlling interest in consolidated subsidiary		443			—					383			—
Total Liabilities and Stockholders’ Equity	$	532,809			1,488				$	491,329			1,476
Net interest income				$	8,660							$	7,839
Interest rate spread							3.29								3.43
Interest expense to average earning assets							0.60								0.66
Net interest margin							3.49	%							3.59	%

(1)

Income and yields are reported on a tax equivalent basis assuming a federal income tax rate of 34 percent.

	Six Months Ended June 30, 2017 Compared to Six Months Ended June 30, 2016
	Increase			Change Due To:
(Dollars in thousands)	(Decrease)			Rate			Volume
Interest income:
Federal funds sold	$	(3	)	$	2		$	(5	)
Deposits in banks		50			6			44
Securities, taxable		95			25			70
Securities, nontaxable		(38	)		(6	)		(32	)
Restricted equity securities		(5	)		—			(5	)
Loans held for sale		4			—			4
Loans		730			(312	)		1,042
Total interest income		833			(285	)		1,118

Interest expense:
Interest bearing liabilities:
Checking		26			12			14
Money market savings		3			2			1
Regular savings		10			(4	)		14
Time Deposits		26			25			1
FHLB borrowings		(58	)		1			(59	)
Subordinated notes		—			(1	)		1
Other borrowings		5			—			5
Total interest expense		12			35			(23	)

Net interest income	$	821		$	(320	)	$	1,141

The year to date provision for loan losses totaled $535 thousand for the six months ended June 30, 2017 compared to $868 thousand for the same period in 2016. See discussion under Allowance for Loan Losses for additional information.

For the year to date through June 30, 2017, noninterest income totaled $1.7 million, an increase of $247 thousand or 16.6% over the same period last year. Gains on the sales of securities were down $172 thousand while ATM and interchange income were up $91 thousand for the first half of 2017 compared to 2016 due to deposit growth and increased customer base. Other income was $244 thousand higher for the six months ended June 30, 2017 compared to the same period last year. Favorable variances from the continued growth of merchant processing income, investment brokerage commission fees, and a one-time bankruptcy settlement of $172 thousand contributed to the increase.

For the six months ended June 30, 2017, noninterest expense was $8.1 million, $1.4 million or 22% more than the $6.6 million recorded in the first half of last year. Salaries and employee benefits for the first half of 2017 were $730 thousand or 22% more than the same period last year. The numbers of full time equivalent employees were 106 and 99 at June 30, 2017 and June 30, 2016, respectively. The increase was due to several factors including the implementation of an in-house credit card program and additional operations personnel to support the continued loan and deposit growth. Other factors included unfilled open positions in the prior year, and new positions to accommodate growth, as well as annual merit raises. Also contributing to the increase was the deferral of less loan origination costs, in accordance with ASC 310-20. As discussed in the quarter to quarter comparison, a write-down on other real estate owned also contributed to higher noninterest expense. Bank Franchise Taxes were also up in correlation with increased equity and a reduction in real estate taxes on foreclosed properties.

Financial Condition

The Company’s management, under the direction of the Asset/Liability Committee (ALCO) of the Board of Directors, reviews the mix of monetary assets and liabilities to ensure the Company maintains an adequate level of liquidity while maximizing interest rate spreads.

Assets totaled $548 million at June 30, 2017, an increase of $30.7 million or 5.9% since year end 2016. The continuing expansion of the net loan portfolio by $15.4 million during the six months since December 31, 2016, accounted for slightly more than half of the asset growth. Excess funds held in liquid cash and due from accounts on the last day of the second quarter 2017 were $19.4 million higher than at December 31, 2016.

The Company’s liabilities at June 30, 2017 totaled $498 million compared to $469 million at December 31, 2016, an increase of $29.1 million or 6.2%. Total deposits rose $25.5 million during the same period to $476 million at June 30, 2017. Core deposits, which exclude brokered deposits and retail CD’s over $250 thousand, totaled $433 million at the end of the first quarter 2017 and were $12.9 million more than at year end 2016.

At June 30, 2017 and December 31, 2016, the stockholders’ equity of HomeTown Bankshares was $49.4 million and $47.8 million, respectively, an increase of $1.6 million or 3.3%. The change in stockholders’ equity in the first six months of 2017 was primarily the result of net income.

Non-performing Assets

Non-performing assets consist of nonaccrual loans, restructured loans, and repossessed and foreclosed assets.

	June 30, 2017		December 31, 2016
(Dollars in thousands)
Real Estate:
Construction and land development	$	—	$	—
Residential 1-4 families		577		577
Commercial real estate		2,748		336
Commercial loans		27		11
Equity lines		—		—
Loans to individuals		—		—
Total nonperforming loans		3,352		924
Other real estate owned		2,768		3,794
Total nonperforming assets, excluding performing restructured loans		6,120		4,718
Performing restructured loans		3,953		6,160
Total nonperforming assets, including restructured loans	$	10,073	$	10,878

Total nonperforming assets, including restructured loans, declined $.8 million during the first six months of 2017. A commercial real estate loan in the net amount of $2.4 million, after a $430 thousand charge-off, was placed on nonaccrual status in the second quarter of 2017. A restructured loan for $2.2 million that was performing at December 31, 2016 was paid off by the borrower in January 2017. A warehouse in Salem, which had been foreclosed on in April 2011 and had been subject to several write-downs, was sold in the first quarter of 2017 without any further loss and accounted for $599 thousand of the reduction in other real estate owned since year end 2016. In addition, an additional write-down was recorded in the amount of $380 thousand during the second quarter of 2017 on one of our residential development properties.

Troubled debt restructurings (“TDR’s”) were comprised of five loans totaling $4.2 million at June 30, 2017. This compares to $6.4 million in total restructured loans at December 31, 2016. Two of the five loans totaling $4.0 million were accruing interest at June 30, 2017. The remaining three loans were to one borrower and totaled $241 thousand and were included in non-accruing loans at June 30, 2017. Two TDRs totaling $549 thousand were past due with their restructured terms at June 30, 2017. See Note 3 for more information.

The major classifications of other real estate owned in the consolidated balance sheets at June 30, 2017 and December 31, 2016 are included in Note 5, and the activity in other real estate owned for the first six months of 2017 and 2016 is also included in Note 5.

Allowance for Loan Losses

The allowance for loan losses is increased by charges to income and decreased by charge-offs, net of recoveries. The allowance consists of three components: specific, general, and unallocated. Their adequacy is evaluated separately. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions. Based on the Company’s allowance for loan losses calculation and analysis at the end of the first six months of 2017, a provision of $535 thousand was recorded. Total net charge offs for the year through June 30, 2017 were $471 thousand. The increase in net charge offs was the main reason for additional provision for loan losses in the second quarter of 2017. Loan growth also contributed to the need for a provision in 2017.

Specific reserves are determined on a loan by loan basis and relate to loans classified as impaired. Management classifies loans as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Included in potentially impaired loan category are current “watch list” credits plus any additional credits which have been past due three or more times within the past 12-month period. Management individually reviews these potentially impaired loans based on generally accepted accounting principles (GAAP) related to receivables and makes a determination if the loan in fact is impaired. Management does not consider a loan impaired during a period of delay in payment if management expects the ultimate collection of all amounts due. If a loan is found to be impaired, an allowance is established when the collateral value less estimated cost to dispose, discounted cash flows, or observable market price of the impaired loan is lower than the carrying value of that loan. Specific reserves for loans individually evaluated for impairment totaled $17 thousand at June 30, 2017 and December 31, 2016. Impaired loans totaled $7.5 million at June 30, 2017, and were $226 thousand less than the balance at year end 2016. The decrease resulted from principal paydowns and the payoff of one loan in full in January 2017 of $2.1 million while offset by the addition of a $2.4 million loan in June 2017.

The percentage of the allowance for loan losses to total loans was 0.85% at June 30, 2017, and 0.87% at December 31, 2016. Unallocated reserves were $27 thousand at June 30, 2017 and $122 thousand at December 31, 2016. Some surplus or unallocated reserve is desirable given the inherent weakness in this type of predictive analysis. The allowance for loan losses to nonaccrual loans was 110% at June 30, 2017 and 394% at December 31, 2016. Past due and non-accruing loans to total loans was 1.42% at June 30, 2017 compared to 0.51% at December 31, 2016. Past due and non-accruing loans are $2.4 million higher due to one loan that was added to non-accrual status in June 2017 and is anticipated to be paid off during the 3^rd quarter of 2017.

Liquidity

Liquidity is identified as the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate withdrawals, payments of debt, and increased loan demand. Liquid assets include cash, federal funds sold, securities classified as available for sale as well as loans and securities maturing within one year. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

The Company’s management, under the direction of the Asset/Liability Committee of the Board of Directors, reviews the mix of monetary assets and liabilities to ensure the Company maintains an adequate level of liquidity at all times. This ensures that the Company’s sources of funds, primarily net fluctuations in customer deposits, investment securities and correspondent banking relationships, must be balanced with the Company’s obligations, commitments, and operational requirements, to maintain overall liquidity in conjunction with the maximization of interest rate spreads.

The Company’s asset based liquidity position, cash and due from bank balances, federal funds sold, loans held for sale, securities available for sale, net of securities pledged and cash balance requirements totaled $73.7 million at June 30, 2017, compared to $59.2 million at December 31, 2016. Higher levels of commercial noninterest bearing deposits contributed to higher levels of liquidity at the end of the second quarter 2017. Commercial deposits remain volatile and withdrawals may result in less liquidity in the future. Surges and declines in commercial deposits will continue to impact liquidity in an unpredictable manner.

The Company’s primary source of funding is its retail deposit base. The Company aggressively markets in its trade area and seeks demand deposits through service-related tactics and savings and time deposits through competitive pricing tactics. If deposits are not an attractive source for funding, either for reasons of maturity or pricing, alternative sources include FHLB advances, brokered deposits, fed funds purchased and lines of credit. The Company is approved to borrow 25% of our total assets from the FHLB subject to providing qualifying collateral. At June 30, 2017, the Company had borrowed $11.7 million of the $25.5 million of lendable collateral value, leaving $13.8 million of unused credit immediately available. The Company also had $36.5 million of fed funds lines of credit available at June 30, 2017. In addition, the Company had access to a $10.0 million credit line through Promontory’s Insured Cash Sweep (ICS) one way buy program at a rate of the one-month LIBOR plus 11 basis points but not less than 20 basis points. At June 30, 2017, there were no advances on the fed funds or credit lines.

Capital

To enable future growth of the Company, there must be an adequate level of capital. Management reviews the Company’s capital to ensure that the amount, composition and quality of the Company’s assets and liabilities satisfy regulatory requirements, meet or exceed industry standards, and support projected Company growth. The Company’s stock is traded on the NASDAQ Capital Market under the symbol “HMTA.”

The ability to pay cash dividends to common stockholders is limited by regulatory restrictions and the need to maintain sufficient capital in the Company and in our subsidiaries. The Company must consider different factors to ensure that any future cash dividends to common stockholders would be prudent relative to the organization’s financial position and not based on overly optimistic earnings scenarios. The Company had $2.4 million of retained earnings at June 30, 2017. No cash dividends were paid to common stockholders in the first six months of 2017.

The Basel III capital framework represents the most comprehensive overhaul of the U.S. banking capital framework in over two decades. This new capital framework and related changes to the standardized calculations of risk-weighted assets are complex and create additional compliance burdens. Basel III rules became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule. The Basel III Capital Rules require significantly more capital and adopted more demanding regulatory capital risk weightings and calculations. As a result of the Basel III Capital Rules, many community banks could be forced to limit banking operations and activities, and growth of loan portfolios, in order to focus on retention of earnings to improve capital levels. The Company believes that it maintains sufficient levels of Tier 1 and Common Equity Tier 1 capital to comply with the Basel III Final Rules. However, increased capital requirements imposed by the Basel III Capital Rules may require the Company to limit its banking operations, retain net income to improve regulatory capital levels, which could negatively affect our business, financial condition and results of operations.

The table presents the Bank’s capital amounts and ratios calculated using the Basel III rules in effect at June 30, 2017 and December 31, 2016.

Risk Based Capital Analysis

Capital Analysis

HomeTown Bank	June 30, 2017		December 31, 2016
(Dollars in thousands)
Common Equity Tier 1 Capital:
Common Stock	$	14,697	$	14,697
Surplus		32,150		32,078
Retained Earnings		9,286		8,008
Common Equity Tier 1 Capital		56,133		54,783
Tier 1 Capital:
Tier 1 Minority Interest		25		17
Tier 1 Capital		56,158		54,800
Total Capital:
Allowance for Loan Losses (allowable portion)		3,700		3,636
Total Capital	$	59,858	$	58,436

The Bank’s total capital increased $1.4 million from December 31, 2016 to June 30, 2017, primarily as the result of the retained $1.3 million ($1.5 million gross minus a $.2 million dividend to the parent company) year to date June 30, 2017 net income attributable to the bank and noncontrolling interest.

The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital. In July 2013, the Federal Reserve Bank issued revised final rules that made technical changes to its market risk capital rules to align it with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final new capital rules required the Bank to comply with the following new minimum capital ratios, effective January 1, 2015: (1) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the previous requirement of 4%); (3) a total capital ratio of 8% of risk-weighted assets (unchanged from current requirement); and, (4) a leverage ratio of 4% of total assets. Beginning January 1, 2016, a capital conservation buffer of .625% became effective. The capital conservation buffer will be gradually increased through January 1, 2019 to 2.5%. Banks will be required to maintain capital levels that meet the required minimum plus the capital conservation buffer in order to make distributions or discretionary bonus payments.

The Bank’s actual capital amounts and ratios are also presented in the following tables:

HomeTown Bank June 30, 2017	Actual					Minimum Capital Requirement including the Capital Conservation Buffer for 2017					Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
(in thousands except for percentages)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to Risk-Weighted Assets)	$	59,858		12.17	%	$	45,503		9.250	%	$	49,193		10.00	%
Tier I Common Equity (to Risk-Weighted Assets)	$	56,133		11.41	%	$	28,286		5.750	%	$	31,975		6.50	%
Tier I Capital (to Risk-Weighted Assets)	$	56,158		11.42	%	$	35,665		7.250	%	$	39,354		8.00	%
Tier I Capital (to Average Assets)	$	56,158		10.47	%	$	21,463		4.00	%	$	26,828		5.00	%

HomeTown Bank December 31, 2016	Actual					Minimum Capital Requirement including the Capital Conservation Buffer for 2016					Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
(in thousands except for percentages)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to Risk-Weighted Assets)	$	58,436		12.59	%	$	40,045		8.625	%	$	46,429		10.00	%
Tier I Common Equity (to Risk-Weighted Assets)	$	54,783		11.80	%	$	23,795		5.125	%	$	30,179		6.50	%
Tier I Capital (to Risk-Weighted Assets)	$	54,800		11.80	%	$	30,759		6.625	%	$	37,143		8.00	%
Tier I Capital (to Average Assets)	$	54,800		10.67	%	$	20,537		4.00	%	$	25,671		5.00	%

Financial Instruments with Off-Balance-Sheet Risk

In the normal course of business to meet the financing needs of its customers, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments involve commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making commitments as is used for on-balance-sheet risk.

At June 30, 2017, outstanding commitments to extend credit including letters of credit were $134 million. There are no commitments to extend credit on impaired loans.

Commitments to extend credit are agreements to lend to a customer as long as there is no breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments may expire without ever being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash outlays for the Company.

Recent Accounting Pronouncements

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in ASU 2016-01, among other things: 1) Requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). 4) Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that ASU 2016-01 will have on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements.

During June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.

During August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments should be applied using a retrospective transition method to each period presented. If retrospective application is impractical for some of the issues addressed by the update, the amendments for those issues would be applied prospectively as of the earliest date practicable. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of ASU 2016-15 to have a material impact on its consolidated financial statements.

During January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”. The amendments in this ASU clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business—inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required to be present. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs. The amendments in this ASU provide a screen to determine when a set is not a business. If the screen is not met, the amendments (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The ASU provides a framework to assist entities in evaluating whether both an input and a substantive process are present. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The amendments in this ASU should be applied prospectively on or after the effective date. No disclosures are required at transition. The Company does not expect the adoption of ASU 2017-01 to have a material impact on its consolidated financial statements.

During March 2017, the FASB issued ASU 2017-07, “Compensation — Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” The amendments in this ASU require an employer that offers defined benefit pension plans, other postretirement benefit plans, or other types of benefits accounted for under Topic 715 to report the service cost component of net periodic benefit cost in the same line item(s) as other compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component. If the other components of net periodic benefit cost are not presented on a separate line or lines, the line item(s) used in the income statement must be disclosed. In addition, only the service cost component will be eligible for capitalization as part of an asset, when applicable. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. The Company does not expect the adoption of ASU 2017-07 to have a material impact on its consolidated financial statements.

During March 2017, the FASB issued ASU 2017‐08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310‐20), Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company is currently assessing the impact that ASU 2017‐08 will have on its consolidated financial statements.

During May 2017, the FASB issued ASU 2017‐09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” The amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The amendments are effective for all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The Company is currently assessing the impact that ASU 2017‐09 will have on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable to smaller reporting companies.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended.) Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II OTHER INFORMATION

Item 1. Legal Proceedings.

In the normal course of business, the Company becomes involved in litigation arising from the banking, financial and other activities it conducts. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results or liquidity.

Item 1A. Risk Factors.

Not applicable to smaller reporting companies.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None

Item 6. Exhibits

(a) Exhibits

Exhibit No.
31.1		Certification of Chief Executive of Officer (302 Certification).

31.2		Certification of Chief Financial Officer (302 Certification).

32		Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).

101*		Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2017, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at June 30, 2017, and December 31, 2016; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2017, and 2016; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2017, and 2016; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016; and (v) Notes to Consolidated Financial Statements.

*	As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

SIGNATURES

Pursuant to the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

HOMETOWN BANK

Date: August 14, 2017	By:	/S/ SUSAN K. STILL
		Susan K. Still
		President
		Chief Executive Officer

Date: August 14, 2017	By:	/S/ VANCE W. ADKINS
		Vance W. Adkins
		Executive Vice President
		Chief Financial Officer

HOMETOWN BANK

FORM 10Q

INDEX TO EXHIBITS

Exhibit		Description
31.1		Certification of Chief Executive of Officer (302 Certification).

31.2		Certification of Chief Financial Officer (302 Certification).

32		Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).

101*

Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2017, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at June 30, 2017, and December 31, 2016; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2017, and 2016; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2017, and 2016; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016; and (v) Notes to Consolidated Financial Statements.

*	As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

HomeTown Bankshares (HMTA) Inactive 10-Q2017 Q2 Quarterly report

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